For struggling commercial property owners, loan modifications can be answered prayers, but without proper tax planning, all hell may break loose come April 15.
That's because income from debt cancellation is taxable, something that is often overlooked as owners scramble to ward off financial ruin. Uninformed real estate owners could find themselves in financial peril when they file their IRS tax returns and owe hundreds of thousands of dollars in unexpected taxes they cannot afford to pay.
Consider the big picture: Commercial loan defaults are posting record-high rates -- and momentum is moving toward worsening default rates through 2015. Real Estate Econometrics expects the default rate to rise to 5.2 percent by the end of 2010 alone.
All this means heightened possibilities for commercial lenders working with overleveraged property owners to forgive a debt rather than waste more resources chasing insolvent borrowers.
"If the borrower is bankrupt, the bank will have no chance to recover the money on a recourse debt, and attempting to collect on a recourse debt from someone who is insolvent may exceed the benefits," said Dennis Fitzpatrick, principal with Kaufman, Rossin & Co. in Miami. "Either way, to the extent that the lender forgives the debt, there is income to the borrower and it is taxable."
If the lender forgives part of the debt, the owner sees a gain as if the property was sold. That gain is the difference between the fair market value of the property and the borrower's basis, along with depreciation on any improvements. With declining market values in mind, the gain could be hundreds of thousands or even millions of dollars.
Although there are no escaping tax laws on the gain from a short sale, the good news is recent changes to tax codes allow borrowers to exclude cancellation of debt income from personal income taxes on recourse loans. The tax code gives companies looking to reduce or restructure debt the opportunity to defer the impact of COD income on debts occurring in 2009 or 2010 for a five-year period.
"This helps taxpayers that are working out their debt and may have losses this year but may have paid taxes in prior years," said Ed Godoy, tax business line leader for the Miami office of BDO Seidman. "They may be able to carry back those losses and not be affected by this income inclusion and even get some refunds from prior years."
Since public debt is frequently bought and sold by third parties, tax experts agree that the landmines are many in the area of forgiveness of debt. The bottom line: forgiveness isn't always a good thing and what you thought was forgiven may come back to haunt you if loans are sold.
The first step in avoiding a financial explosion on the IRS front is for the borrower to understand his tax position based on the type of corporate entity that owns the property.
"Borrowers need to get into discussions with their lenders and understand the ramifications of these decisions," Fitzpatrick said. "You need to know what the real cost is going to be of accepting debt forgiveness on a distressed property because there could be costs down the road that aren't so obvious."
CAPITALIZATION RATE IMPACT – PERCENTAGE CHANGE IN PROPERTY VALUE AS CAP RATE INCREASES
Old Cap Rate >> 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00%
New Cap Rate
6.00% -8.30%
6.50% -15.40% -7.70%
7.00% -21.40% -14.30% -7.10%
7.50% -26.70% -20.00% -13.30% -6.70%
8.00% -31.30% -25.00% -18.80% -12.50% -6.30%
8.50% -35.30% -29.40% -23.50% -17.60% -11.80% -5.90%
9.00% -38.90% -33.30% -27.80% -22.20% -16.70% -11.10% -5.60%
9.50% -42.10% -36.80% -31.60% -26.30% -21.10% -15.80% -10.50% -5.30%
10.00% -45.00% -40.00% -35.00% -30.00% -25.00% -20.00% -15.00% -10.00%
10.50% -47.60% -42.90% -38.10% -33.30% -28.60% -23.80% -19.00% -14.30%
11.00% -50.00% -45.50% -40.90% -36.40% -31.80% -27.30% -22.70% -18.20%
Market Snapshot—Monday’s closes (6-14-10) are in parentheses
Treasury Yields Key Indicators Other Key Indicators
2-yr 0.71% (0.73%) DJIA: 10451 (10211) Prime Rate: 3.25%
5-yr 2.01% (2.03%) NASDAQ: 2310 (2244) Fed Reserve Target Rate: 0.25%
10-yr 3.22% (3.23%) S&P 500: 1117 (1092) U.S. Unemployment Rate: 9.70%
30-yr 4.14% (4.15%) S&P 100: 504 (493)
LIBOR NYSE Comp: 6988 (6814)
1- Mo. LIBOR: .35% (.35%) Crude Oil: $77 ($74)
3-Mo. LIBOR: .54 (.54%) Gold: $1258 ($1229)
Until next week -
Brad Cox, CCIM, CPM
Senior Vice President - Debt Placement
Thomas D Wood and Company
Office: (941) 552-9731
Email: bcox@tdwood.com
Monday, June 21, 2010
Monday, June 7, 2010
Multifamily suffers nationally as CMBS delinquencies are on the rise.
WEEKLY MARKET COMMENTARY - AS OF JUNE 7, 2010
HISTORICAL CMBS DELINQUENCIES CONTINUE - Delinquencies in commercial mortgage-backed securities continued at historical highs in May, up 40 basis points to 8.42 percent, said Trepp LLC, New York.
Trepp recorded 8.02 percent in CMBS delinquencies in April for CMBS loans more than 30 days delinquent. The firm said the overall delinquency rate would be nearly 9 percent “if defeased loans were taken out of the equation.”
Seriously delinquent loans—more than 60 days in foreclosure, real estate owned (REO) or non-performing balloons—were up 41 basis points to 7.55 percent.
Fitch Ratings, New York, said average loss severities for its U.S. CMBS rated universe will continue to exceed historical averages through the end of 2011.
In Fitch's U.S. CMBS Loss Study, the ratings agency said it expects higher loss severities for all property types this year. Annual loss severities by property type last year were at 58 percent for multifamily; 48.2 percent for retail; office at 56.9 percent; industrial at 48.8 percent and hotels at nearly 82 percent.
In its monthly delinquency report, Trepp said multifamily had the highest delinquency rate among major property types, up 28 bps to 13.34 percent, and lodging—hotel delinquencies—jumped nearly 130 bps to 18.45 percent. Office delinquencies approached 6 percent—now at 5.81 percent—after up 44 bps from April, and retail CMBS delinquencies increased 42 bps to more than 6.86 percent. Only industrial properties posted a delinquency rate decline among major property types.
Fitch said its overall view of the CMBS sector remains negative, and maturations for 10-year fixed rate 2005 to 2007 vintages are fewer than five years away.
Fitch's 2009 losses were primarily in the 1998 vintage, led by the hotel sector, and the 2006 vintage, dominated by multifamily losses.
Fitch reported underperforming properties in states with weak economies, which led to an increase in rated U.S. CMBS delinquencies for April to 7.48 percent.
Brad Cox, CCIM, CPM
Senior Vice President - Debt Placement
Thomas D Wood and Company
Email: bcox@tdwood.com
HISTORICAL CMBS DELINQUENCIES CONTINUE - Delinquencies in commercial mortgage-backed securities continued at historical highs in May, up 40 basis points to 8.42 percent, said Trepp LLC, New York.
Trepp recorded 8.02 percent in CMBS delinquencies in April for CMBS loans more than 30 days delinquent. The firm said the overall delinquency rate would be nearly 9 percent “if defeased loans were taken out of the equation.”
Seriously delinquent loans—more than 60 days in foreclosure, real estate owned (REO) or non-performing balloons—were up 41 basis points to 7.55 percent.
Fitch Ratings, New York, said average loss severities for its U.S. CMBS rated universe will continue to exceed historical averages through the end of 2011.
In Fitch's U.S. CMBS Loss Study, the ratings agency said it expects higher loss severities for all property types this year. Annual loss severities by property type last year were at 58 percent for multifamily; 48.2 percent for retail; office at 56.9 percent; industrial at 48.8 percent and hotels at nearly 82 percent.
In its monthly delinquency report, Trepp said multifamily had the highest delinquency rate among major property types, up 28 bps to 13.34 percent, and lodging—hotel delinquencies—jumped nearly 130 bps to 18.45 percent. Office delinquencies approached 6 percent—now at 5.81 percent—after up 44 bps from April, and retail CMBS delinquencies increased 42 bps to more than 6.86 percent. Only industrial properties posted a delinquency rate decline among major property types.
Fitch said its overall view of the CMBS sector remains negative, and maturations for 10-year fixed rate 2005 to 2007 vintages are fewer than five years away.
Fitch's 2009 losses were primarily in the 1998 vintage, led by the hotel sector, and the 2006 vintage, dominated by multifamily losses.
Fitch reported underperforming properties in states with weak economies, which led to an increase in rated U.S. CMBS delinquencies for April to 7.48 percent.
Brad Cox, CCIM, CPM
Senior Vice President - Debt Placement
Thomas D Wood and Company
Email: bcox@tdwood.com
Tuesday, June 1, 2010
How is Commercial Real Estate Getting Done. These Guys Know!
FEWER TRANSACTIONS PRODUCE VALUATION UNCERTAINTIES -
Values are going to be a slippery slope for probably the next 24 months until real sales get out there in the market to provide some (comparables)," said Paul Smyth, president of Centerline Servicing LLC, Irving, Texas.
Speaking recently at the Mortgage Bankers Associations Commercial/Multifamily Servicing and Technology Conference, Smyth said fewer current comparables and distressed sale comparables drive significant valuation differences in appraisals—some set even one week apart.
"Alot of it is subjective. You really don't know in a lot of cases until you are actually exposed to the market," Smyth said.
While appraisals remain unreliable, borrower special request volume at Berkadia Commercial Mortgage LLC, Horsham, Pa., increased by nearly four-fold after last year, said Mark McCool, executive vice president.
"Our CMBS (delinquencies) continue to creep up; therefore, our appraisal needs continue to creep up. They remain as unreliable as they ever have been, probably more so at this point," McCool said. "It is incredibly difficult to think from a valuation perspective from the appraisals. It is incredibly difficult."
"Appraisers are having trouble getting their arms around value when there are only so many comps," said Steven Smith, president and COO at PNC Real Estate/Midland Loan Services Inc., Overland Park, Kan. "Appraisals are, by nature, a backward looking exercise, and there are just not many data points for appraisers to settle on."
Smith said assumptions are "a little too aggressive" on recovery amount; PNC/Midland does not agree on stabilized value. It will rely on broker opinion value and, based on the market, PNC/Midland will develop its own value.
Some feedback within the CMBS capital stack showed investors within the stack disagree with the appraisals, Smith added. "We try to do what is best for all certificate holders in the trust," he said. "It is not always a clear deposition and you just don't make everybody happy."
In 2007, Midland completed five modications; four in 2008; 50 modifications in 2009 and 53 modifications year-to-date. However, pressure continues to mount for servicers. "Even though it ebbs and flows, there is an average 300 questions a month from ratings agencies," Smyth said.
Centerline assigns a special asset group for government-sponsored enterprises and a special, separate group in CMBS, Smyth said. With critical mass in special servicing, Centerline subdivides areas trying to keep 15 loans per asset manager, different from the Resolution Trust Corp., which handled north of 100 during the early 1990s.
Smith said PNC's Midland expects questions on special servicing issues to double this year; and the servicer started tracking those queries last year.
"We are seeing a pretty healthy increase in questions come in related to maturities, related to tenant issues, whether they are tenant rollovers or lease renewals or just basic questions—very detailed questions—about lease information," Smith said. "We can expect questions about the watchlist, delinquencies and ARDs (anticipated repayment dates)."
Greater scrutiny also necessitates other analysis for valuation besides the appraisal, Smyth said.
"It's like working out loans in the Roman arena now because the whole world is watching you," Smyth said. "It's a very different arena to work out loans and the credit values are not the only value."
Brad Cox, CCIM, CPM
Email: bcox@tdwood.com
Values are going to be a slippery slope for probably the next 24 months until real sales get out there in the market to provide some (comparables)," said Paul Smyth, president of Centerline Servicing LLC, Irving, Texas.
Speaking recently at the Mortgage Bankers Associations Commercial/Multifamily Servicing and Technology Conference, Smyth said fewer current comparables and distressed sale comparables drive significant valuation differences in appraisals—some set even one week apart.
"Alot of it is subjective. You really don't know in a lot of cases until you are actually exposed to the market," Smyth said.
While appraisals remain unreliable, borrower special request volume at Berkadia Commercial Mortgage LLC, Horsham, Pa., increased by nearly four-fold after last year, said Mark McCool, executive vice president.
"Our CMBS (delinquencies) continue to creep up; therefore, our appraisal needs continue to creep up. They remain as unreliable as they ever have been, probably more so at this point," McCool said. "It is incredibly difficult to think from a valuation perspective from the appraisals. It is incredibly difficult."
"Appraisers are having trouble getting their arms around value when there are only so many comps," said Steven Smith, president and COO at PNC Real Estate/Midland Loan Services Inc., Overland Park, Kan. "Appraisals are, by nature, a backward looking exercise, and there are just not many data points for appraisers to settle on."
Smith said assumptions are "a little too aggressive" on recovery amount; PNC/Midland does not agree on stabilized value. It will rely on broker opinion value and, based on the market, PNC/Midland will develop its own value.
Some feedback within the CMBS capital stack showed investors within the stack disagree with the appraisals, Smith added. "We try to do what is best for all certificate holders in the trust," he said. "It is not always a clear deposition and you just don't make everybody happy."
In 2007, Midland completed five modications; four in 2008; 50 modifications in 2009 and 53 modifications year-to-date. However, pressure continues to mount for servicers. "Even though it ebbs and flows, there is an average 300 questions a month from ratings agencies," Smyth said.
Centerline assigns a special asset group for government-sponsored enterprises and a special, separate group in CMBS, Smyth said. With critical mass in special servicing, Centerline subdivides areas trying to keep 15 loans per asset manager, different from the Resolution Trust Corp., which handled north of 100 during the early 1990s.
Smith said PNC's Midland expects questions on special servicing issues to double this year; and the servicer started tracking those queries last year.
"We are seeing a pretty healthy increase in questions come in related to maturities, related to tenant issues, whether they are tenant rollovers or lease renewals or just basic questions—very detailed questions—about lease information," Smith said. "We can expect questions about the watchlist, delinquencies and ARDs (anticipated repayment dates)."
Greater scrutiny also necessitates other analysis for valuation besides the appraisal, Smyth said.
"It's like working out loans in the Roman arena now because the whole world is watching you," Smyth said. "It's a very different arena to work out loans and the credit values are not the only value."
Brad Cox, CCIM, CPM
Email: bcox@tdwood.com
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